Trained in Risk

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Kristi Matus brings a different orientation to the CFO’s office. Formerly the chief operating officer of a bank, Matus took a position in 2002 as an actuary developing life-insurance products at USAA, a financial-services company serving the armed forces. The role suited Matus, who has a degree in applied mathematics. But so does the CFO spot, a position she was promoted to in January 2008.

Matus helped the company produce its best year ever in 2009, with revenue of $17.6 billion and net income of $3 billion, up from $12.9 billion in revenue and $423 million in profits in 2008. During the financial crisis, the firm was helped by being member-owned and by the fact that it exclusively serves military personnel, military retirees, and their families. The loss rates in its bank lending unit run about one-third of the industry average, for example, and a flight to quality in consumer deposits clearly benefited the firm’s balance sheet. A tech-savvy clientele (courtesy of its military training) also keeps customer-service costs down.

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But Matus’s actuarial background also helped USAA during the crisis, particularly by disposing her to take the long view when other financial-market participants were panicking over falling asset prices and disappearing liquidity. Today she continues to monitor a boatload of risks, with asset management, insurance, and banking units in the company’s portfolio. CFO sat down with Matus recently to discuss her background and how USAA weathered the financial crisis so well. An edited version of the interview follows.

How does having an actuarial background affect your thinking as CFO?

When you’re a life-insurance actuary, every decision you make has a 30-year tail. You have to think about what’s going to happen next quarter and next year, but you can’t make a decision without thinking about what is it going to look like in 30 years or having some sense of how that’s going to model. Also, the actuarial role puts you in a situation many times where you’re the coordinator or the moderator between sales and finance. So as you set prices for products, how do you trade off between profitability or margin on the individual product versus the volume that could be generated? As you run those models early in your actuarial career, you really understand the bottom-line financial impacts of day-to-day business decisions.

What have been your greatest challenges as finance chief?The environment of uncertainty. Navigating through the financial crisis, through what we would call “the fog of war,” was challenging. For example, at the end of 2008, bond spreads widened way out, which severely impacted our fixed-income portfolio. Do you panic like everyone else and try to ditch these holdings, or are you confident in the decisions that you made? We felt pretty confident, so we held. As bond spreads came back in, we were able to recapture those unrealized losses.

A lot of things that impacted us are the same things that impacted any firm on Wall Street. But we’re different in terms of our ownership structure, because our members own us. So when the markets are rocky, I don’t have to make trade-offs between what’s in the best interest of my shareholders and what’s in the best interest of my customers — they are the same.

How has the soft market in insurance affected you?We have one of the lowest expense ratios in the property-and-casualty business, which allows us to hold our breath in soft markets. [An insurer’s expense ratio is underwriting expenses divided by the premiums earned on insurance contracts.] Last year some competitors had ratios well in excess of 100%. We’re running in the 95%, 96% range.

How do you keep your expense ratio low?First, we don’t pay any commissions. That’s a big part of the cost structure, especially for agent-driven companies. While we do some advertising and marketing and we’re becoming more aggressive, we don’t have nearly the budget that competitors like Geico have. Finally, the biggest key to our expense management over the last couple of years has been electronic transactions. We have very robust mobile capability. Because we’ve invested so much in technology, last month more than 83% of our incoming service transactions were electronic. We’ve been able to shift a lot of service — a lot of the high-maintenance things — to electronic channels while maintaining customer satisfaction.

Many studies show that boards of directors are still not well informed about the risks that financial-services firms are taking day-to-day. How are you addressing that?The finance and audit committee of our board of directors has the primary responsibility for risk oversight. I have an absolute hard-and-fast requirement that at every board meeting — there are four per year — we will bring in some topic of risk. Typically at our board meeting in August, we identify our 10, 12, 20 biggest risks, and we quantify those. Here’s how big we think they are; here’s how we’re going to mitigate them; here are the ones we really have our eyes on. Throughout the course of the year we will highlight some of these risk areas. For example, last year I showed the full board some of the analysis and stress testing that we had done around liquidity shocks at USAA.

Is reputational risk in your portfolio?Reputational risk is probably our number-one risk. I think it’s the primary one at the end of the day. You can have financial risks, operational risks, legal and regulatory risks. If you don’t have plans in place to manage those quickly, they all become reputational risk in some way, shape, or form.

Last year we brought in the Reputation Institute [a research and consulting firm] to help us put together an overall plan. What is USAA’s reputation in the marketplace today? What are some of the gaps that members see? How would we protect that [reputation] over time? For example, if we had an information-security leakage, that could be big. We manage information security very tightly, but that doesn’t mean that something bad couldn’t still happen. So if it did, then what actions would we take? What would we do immediately to protect members’ account information?

Some of these things you have to think through in terms of mitigation and contingency plans. And to me, reputational risk falls in the category of contingency planning. There’s some mitigation in terms of building a strong brand and making sure members know that no matter what, they can count on you and trust you. But if something bad happens, I need a contingency plan that I can go to.

What do you see on the horizon in terms of financial reform?I wish I had that crystal ball. At USAA, we believe that comprehensive financial regulatory reform is needed. And we welcome anything that would protect members or protect their ability to gain and accrue financial security. When we look at some of the proposals, we really like the federal insurance office contemplated in both the Senate and the House versions of the reform bill. What would concern us is if you have a hodgepodge of federal agencies, each overseeing just a small part of the equation. You might argue that that’s part of the issue today. But if we could have comprehensive real reform focused on helping consumers and keeping institutions safe and sound — it has to be both of those — then we think we win.